One of the more wonky aspects of nonprofit management involves the endowment (if you’ve got one) and how much you can draw from it each year. As most will know, an endowment is a bucket of money that has been permanently restricted as an asset, intended to spin off interest and build equity over time to support the mission of the institution.
Since endowment investments rise and fall with the markets, which makes planning year-to-year a challenge, most institutions invoke a ”rolling average” of the endowment’s value (usually spanning three years, aka twelve quarters) to soften the peaks and valleys when they calculate their annual draw. Wonky…I told you.
And while the general policy of drawing a conservative percentage (4 to 6 percent perhaps) from a rolling average of the endowment’s value every year has, indeed, tended to soften the impact of market cycles and encourage growth, the market collapse of late last year has thrown a rather vexing wrench into the strategy.
When your endowment value rises and falls within reason, rolling averages smooth the ride. But when your endowment value drops off a cliff — by 30 to 50 percent — that same strategy creates a long, downward slope extending to the horizon. That’s the challenge facing any nonprofit that depends significantly on its endowment (universities, museums, major symphonies, and the like). And that challenge is rather elegantly and frankly described by Stanford University President John Hennessy in this speech excerpt from last April. Says he:
If we were to set the endowment payout by blindly applying the
smoothing rule, we would likely see more than five years of decreasing
annual payouts and several additional years where the endowment would
grow by less than inflation. This would lead to many years of
successive budget cutting, continuing long after the economy had
recovered.
That bleak game of ‘catch up’ is leading many such institutions not just to duck and cover — making temporary cuts and deferring expenses — but rather to realign their base budget, and redefine what they do (and what they won’t do anymore).
It’s an increasingly visceral example of wonky policy impacting real people in dramatic ways. And it’s a useful moment to wonder out loud how resilient your organization’s investment decisions and board practices are — and how nimble you are when a change to common practice is required.
Hmm, I get your point, but are you suggesting institutions should rip off the band-aid all at once instead and go to a drastically reduced budget the next year? It’s not clear to me that either is necessarily a better strategy than just sticking with Plan A. Sure, if there’s fat in the system it’s a good opportunity to get rid of it. But if not, it could lead to a lot of lost perfectly good talent and programming that would be much more expensive to get back later when the economy is on its feet again. So in some cases it might make sense to just tough it out in hopes of positioning better for the recovery.